The Billionaire Who Led Sears Into Bankruptcy Court

Financial engineers like Eddie Lampert are wreaking havoc on American companies.

By William D. Cohan

Mr. Cohan is a former investment banker and the author of four books about Wall Street.

Oct. 16, 2018

Image

Eddie Lampert's big bet on merging Sears and Kmart never really paid off.CreditCreditVincent Laforet/The New York Times

When Sears, once America’s largest retailer, made its bankruptcy filing Monday in a White Plains courthouse, the proximate cause was the decision by Eddie Lampert, by far its biggest individual creditor and shareholder, not to make a $134 million loan payment that was due. “This is not so much a melting ice cube, but a puddle,” a lawyer for a large creditor told the federal Bankruptcy Court.

But in the end, this wasn’t simply about a struggling retailer unable to pay its bills. Sears succumbed to Mr. Lampert’s hubris. The problems at Sears Holdings, as it is known on Wall Street, are more than a decade in the making, all because one of the smartest guys who has ever been in any room — Mr. Lampert — stayed convinced of his own deeply flawed thinking. As a result, billions of dollars of shareholder and creditor money has been immolated, probably forever; at least 175,000 jobs have been lost; and one of the greatest American business success stories may well be extinguished.

It’s yet another cautionary tale about the limits of financial engineering.

It didn’t have to be this way. Mr. Lampert began this 15-year odyssey in 2003 after he bought the bonds of the failing discount retailer Kmart and converted those bonds into a controlling position in Kmart’s equity. He ran his own hedge fund, ESL, investing money from wealthy billionaires such as David Geffen, the Ziff family and Michael Dell. Using their money, and some of his own, Mr. Lampert became a billionaire, too, with gargantuan successes investing in, among others, AutoZone, an auto parts retailer, and AutoNation, a car retailer. He saw opportunities where others did not, often won big, and became an investing legend.

His early success at Kmart wowed Wall Street. In 2003, the operating profit at Kmart was around $400 million; the next year, it was $900 million. That’s about when the hubris kicked in. He thought he knew something about retailing, even though what he really knew about was financial engineering. In 2005, he merged the rejuvenated Kmart with Sears, then a conservatively run but still thriving nationwide retailer. “Kmart was a turnaround,” he told me in a rare 2017 interview for Vanity Fair. “Putting Kmart and Sears together was a transformation.”

Mr. Lampert was wrong about that. He decided not to invest the capital needed to refurbish the Sears and Kmart stores to keep their inventory and appearance fresh. Instead, he made a huge gamble, one that never really paid off, to invest in Sears’s website and online shopping. He was too early, and the Sears customer base never cottoned to shopping online. Instead, Amazon ate Sears’s lunch (and breakfast and dinner) until he threw in the towel this year and joined forces with Amazon to allow it to sell Kenmore appliances, something that he long refused to do.

It was too little too late. Desperation had set in. Mr. Lampert used every financial engineering tool he had ever learned. (He and the company have disputed that notion, insisting that Sears’s financial moves have all been part of an operational strategy.) He began selling off Sears’svaluable brands, including Craftsman tools, which went to a competitor; he carved out hundreds of Sears stores into a separate publicly traded company that he and other wealthy investors controlled; and he became Sears Holdings’ largest creditor and shareholder.

Most others would have bailed years earlier. Not Mr. Lampert. It really was little more than an intellectual exercise. Could he figure out ways to save Sears and Kmart from bankruptcy, even though nearly everyone told him he could not? The answer, of course, was no.

But that’s not the end of the story. Since Mr. Lampert is Sears’ largest single creditor, he is in a position to control the company again if and when it is able to emerge from bankruptcy protection. Mr. Lampert appears to be gearing up for that outcome. He’s still the chairman of the Sears board of directors, although he gave up his role as chief executive as part of the bankruptcy filing. He’s also proposed making a new secured $300 million loan to enable the company to continue operating in bankruptcy. And he’d still like to buy the Kenmore brand, one of its most valuable properties, from Sears for $400 million. It will be up to a bankruptcy judge to decide.

The question is, why would anyone give him that chance? Yes, many old-economy retailers have failed to adapt to consumers’ changing needs. But the wizards of financial engineering — whether it’s Mr. Lampert at Sears or the venerable buyout firm KKR at Toys "R" Us — have not done much better. The next time the Masters of the Universe come knocking with a buyout proposal, a smart company may want to lock the boardroom door.

William D. Cohan is a special correspondent for Vanity Fair and the author of, most recently, “Why Wall Street Matters.”